The Recovery's New Clothes

I sometimes feel that the economy is living out the Hans Christian Andersen's
fable called "The Emperor's New Clothes". He wrote the story back in 1837 about
a vain emperor who hired a couple of charlatans that promise to make him the
finest robes out of invisible thread. They convinced the Emperor that anyone
not appreciating the sartorial splendor of the two swindlers should be deemed
hopelessly stupid and unfit for their positions.

The current economic "recovery" and stock market rally have many similarities
to Mr. Anderson's work. The underlying fundamentals behind the S&P 500's
180% advance since March of 2009 should be blatantly recognized as phony, even
to a child. Yet traders and economists appear to willingly overlook the nakedness
of it all.

There has been a subpar increase in personal income, employment, corporate
revenue and GDP since the supposed end of the Great Recession back in the summer
of 2009. But the key point to understand is, whatever phony growth that has
been achieved came from governments' ability to borrow and print enough money
to keep asset prices from plummeting. One can't say that equity and real estate
values are soaring once again because the economy has healed, and therefore,
it's has nothing to do with the Fed. Without the support of protracted and
humongous monetary welfare, gratis of the central bank, debt levels, money
supply and asset prices would need to contract to a level that can be supported
by markets-rather than by government decree.

For example, the U.S. has incurred an additional $6 Trillion more in total
debt than it had at the end of 2007. What our government and central bank have
been able to achieve is set in stone our economy's addictions to debt, low
interest rates and money printing by taking all of those conditions into incredible
extremes. The Fed has kept the short end of the yield curve at zero percent
for over five years and promises to keep interest rates there for as far as
its eyes can see. Our central bank has also increased the amount of high-powered
money from $800 billion to $4.2 trillion-and that number is still growing.

The economy and markets are much further away from removing the hand of government
manipulations than at any other time in our nation's history. There has been
no structural or entitlement reforms done at all. In contrast, Washington has
succeeded in piling on an additional entitlement program (The Affordable Care
Act), which the nation has no capability of paying for, adding to the myriad
of entitlement programs that are already insolvent. Nothing of substance has
changed for the good, only the government's ability to massively increase the
amount of aggregate debt outstanding and appear to remain solvent by temporarily
servicing that debt at an artificially-low rate.

Economically sensitive markets are clearly exclaiming that this recovery is
naked. Industrial metals like copper have fallen 17%, while aluminum is down
10% YOY. Also, emerging market currencies and equity markets are reeling from
the end of the dollar carry trade. However, faltering economic data in the
U.S. has been conveniently and summarily dismissed due to winter's snow. But
unless we are headed into another ice age, the excuse of cold weather will
soon be undressed with the spring thaw.

The hole in the weather excuse is that the entire globe is showing signs of
weakness. Chinese exports tumbled 18.1% from the year ago period, while the
Shanghai stock market was down 12.5% during the same time frame.

The obscene amount of money printing by the Bank of Japan has caused the current
account deficit to hit yet another all-time record high. The deficit for January
was 1.59 trillion Yen ($15.4 billion) and the overall economy grew just 0.7%
on an annualized basis in the final three months of 2013. This was a downward
revision from the initially projected 1% growth rate.

The government of Japan is a paragon of the Keynesian experiment to avoid
a cathartic recession by forcing higher the rate of money supply growth, depreciating
the currency, levying new taxes, creating more inflation and drastically increasing
the amount of aggregate debt outstanding. It has been well over a year since
Abenomics took over in Japan and its failure should be nakedly obvious. Soaring
debt levels, huge trade imbalances, a plummeting currency, a sputtering economy
and insolvency are the tradeoffs for a stock market that is rising in nominal
terms, and not yet back to the where it was before the Great Recession began
over five years ago.

Given the above facts, it seems silly to buy into the belief that the global
economy is on a sustainable growth pattern. Yet, the overwhelming majority
of market pundits purport that fable to true. Perhaps, it is just more expedient
and profitable to agree with what our leaders tells us is the truth, rather
than to trust what our own eyes see and conscience dictates.

The sad truth is that global governments, in cooperation with their central
banks, have now rendered much of the developed world insolvent. And that condition
will be made evident to all once interest rates rise and the artificial support
of bonds, stocks and real estate is finally, either voluntarily or involuntarily,
removed.

For now, investors have decided to ignore the obvious and pretend that the
economy-much like the townsfolk in Anderson's story--is in "excellent and magnificent" condition.
But, once the economy crashes yet again, we will understand with the clarity
of hindsight that the recovery was completely bare.

PPS is a Registered Investment Advisory Firm that provides money management
services and research for individual and institutional clients.

Michael is a well-established specialist in markets and economics and a regular
guest on CNBC, CNN, Bloomberg, FOX Business News and other international media
outlets. His market analysis can also be read in most major financial publications,
including the Wall Street Journal. He also acts as a Financial Columnist for
Forbes, Contributor to thestreet.com and is a blogger at the Huffington Post.

Prior to starting PPS, Michael served as a senior economist and vice president
of the managed products division of Euro Pacific Capital. There, he also led
an external sales division that marketed their managed products to outside
broker-dealers and registered investment advisors.

Additionally, Michael has worked at an investment advisory firm where he helped
create ETFs and UITs that were sold throughout Wall Street. Earlier in his
career he spent two years on the floor of the New York Stock Exchange. He has
carried series 7, 63, 65, 55 and Life and Health Insurance Licenses. Michael
Pento graduated from Rowan University in 1991.